Here is another CEO who clearly believes lowering prices does not automatically guarantee sales increase: Macy’s Terry J. Lundgren. In his inteview with The Wall Street Journal, Mr. Lundgren said,

WSJ: Do you think about lowering your average selling price or changing your product blend, as some of your competitors have done?

Mr. Lundgren: Here’s the challenge. We have [a men’s pants brand], and they typically go out the door between $29.50 and $32.50, with all the coupons and everything.

What Mr.Lundgren refers to as “out the door price” is the “pocket price“, the net price after all discounts. The net effect of the discounts and coupons is price leakage that erodes profit, clearly Mr. Lundgren is driving Macy’s to focus on its price waterfall.

Our purchasers are women. She’s spending the same amounts but just shopping with a great deal of discretion. Value is the word, even if it’s at regular price. The intrinsic value of what she’s buying is very important.

Incremental analysis: How much should sales rise to compensate for loss in profit from price cuts? (Lundgren is on the direction but he is comparing top-line while he should be doing incremental math on lost profit. There is also numbers error as pointed out by the commenter.)

So we were getting tremendous sell-through at low price points and no margins. And I am not making my pants sales for last year, because my average sale dropped by 30%. It’s really hard to make the math work. I have to have 30% more transactions on this product to break even.

Customer Margin: Understanding that loss leaders are effective only if they help generate incremental profit from customers who are attracted to the stores by low prices of loss leaders.

We and the manufacturer together agreed to mark them (pants) down to $21.99 or something like that. Selling like hotcakes. Every other pants around them stopped selling.

It is time to give some definitions of pricing terminologies, specifically definitions of Price Realization, Price Leakage, Pocket Price and Pricing water fall. I will explain these concepts in the B2C context (a retailer), for a B2B explanation see this. Seen above is a picture that shows the pricing for a queen mattress at a JCPenney store. The prices and discounts are taken from a store visit. (Note that I did not consider interest income earned from credit card balance.)

List Price: Price is the method to capture value added by a product. The most common way to indicate prices to customer is the list price, be it price tags in retail or invoice price in B2B transactions.

Price Leakage: Unfortunately, both in B2B and B2C scenarios, a business is unable to get the customer to pay the list price. Due to sales pressures, competitive offerings and other macro-economic factors, the prices are marked down. Different discounts applied to the list price are referred to as Price Leakage. In the figure above, price leakages are show in color red. Last week JCPenney was running a 50% off sale with an additional 15% customer appreciation coupon. On top of these if a customer were to open a store credit card they gave an additional 10% off. JCPenney is also running a frequent shopper program called JCPRewards that gives back $10 for every $250 spent.

Pocket Price: The pocket price, the price finally collected after all applicable discounts, is significantly less than the list price. This is still not profit, because it does not include sales commission (if any) and marginal cost of the item sold.

Pricing Waterfall: The picture says it all.

Price Realization: Price realization is about decreasing price leakage, increasing pocket price and hence keeping a higher proportion of the list price that flows directly to the bottom line (profit). Price realization can be in the form of higher list price, fewer discounts, additional charges or decrease in service offered (see Cadbury’s methods on this).